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Hedge Funds Are Ready for New Boom in Start-Ups

Date: Tuesday, November 10, 2009
Author: Matthew Lynn, Bloomberg.com

There are tough new regulations on the horizon. There are scandals and arrests. Investors, shaken by the credit crunch, are nervous about taking risks.

Yes, there has never been a better time to polish your CV, shine your shoes and start a new hedge fund.

The world is perfectly poised for hedge funds to make huge sums of money in the next five years. Asset prices are still way off their highs. The “carry trade” that allows you to borrow cheaply is back. Most of all, there are bubbles popping and fizzing all over the world.

Hedge funds are ready to mint themselves a fortune again. The only question is: When should you get on that bus?

Politicians are menacing the industry with new rules that are prompting many London-based funds to move to Switzerland.

The industry is also beset by scandal. Helmut Kiener, who founded the K1 Group hedge-fund firm, was arrested in Germany last week, and Raj Rajaratnam, the Galleon Group hedge-fund founder, was taken into U.S. custody on insider-trading charges last month.

Those incidents, particularly after the Bernard Madoff fraud, taint the whole industry. Nobody wants to put their money into an investment if they suspect they won’t get it back.

So you wouldn’t be surprised if ambitious young financiers decided they should be battening down the hatches, and clinging on to their jobs until the prospects for the industry improve. If they didn’t climb on board the hedge-fund bandwagon in 2005 and 2006, maybe it’s too late.

‘We Are Done’

“Goodbye and Good Luck,” Hedgefundlaunch.com said in a final posting dated April 15. “The financial system has lost all credibility with the scandals, implosions, bailouts and what not. Therefore, we are done.”

The pessimism was premature.

This month, there have been some high-profile launches. Steve Mathews, formerly head of commodities research at Tudor Investment Corp., is opening a new commodity fund in January. Stuart Wilson and Teall Edds, formerly senior portfolio managers at Stark Investments, are starting a new fund called Orchard Capital Partners Ltd. in Singapore. Andrew Barker and Raymond Maguire, former managing directors at UBS AG, are starting a transport fund with the backing of Tufton Oceanic Finance Group, which runs the world’s biggest shipping hedge fund.

Crazy? Not really. It may be time to quit that safe job and start a hedge fund.

Fair Value

There are three reasons for that.

First, you need to begin a fund when equity markets are cheap or fairly valued. The 20 percent fee that hedge funds typically charge only kicks in when the fund is in profit. It is only possible to make big money if you start the fund when the markets aren’t in a bubble. If you launch near the peak, you’ll be underwater for years, unless you start a short-selling fund. Wait another year, when this bull run may near its top, and you’ll be too late.

Second, the “carry trade” is back. You can borrow money cheaply in the U.S. and the U.K., then reinvest the money in higher-yielding currencies and assets. For much of the last decade, the hedge funds were doing that with the Japanese yen. Now they can do it with the dollar and the pound as well.

The hedge funds with their nimbleness, their ability to use massive leverage, and their flexibility are the one investment vehicle that can really take advantage of that.

Third, the determination of central banks to reignite the global economy by flooding the markets with printed money is creating asset bubbles everywhere. They are popping up so fast, and so obviously, even former Federal Reserve Chairman Alan Greenspan could spot them. You can take your pick from the Australian dollar, emerging-markets equities, or gold.

Hot Money

Next week, something else will probably be soaring in price -- cotton, Bulgarian real estate, or the South African rand, perhaps. Coal derivatives are looking perky. In a world where there is a lot of hot money and not much economic growth, there will be bubbles, big and small. The money has to go somewhere.

No other investment vehicle is as well-placed as hedge funds to exploit those conditions. Spotting bubbles is what hedge funds are made for. The only trick is to recognize the bubbles early and get out before they burst. But the more of them there are, the easier that is. The funds thrive on volatility, and there’s a lot of that around right now.

There are fortunes to be made from hedge funds in the next few years. All you need is somewhere to base yourself where you won’t be taxed and regulated out of existence.

(Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Matthew Lynn in London at matthewlynn@bloomberg.net.